At this point, it’s safe to say that most folks are exhausted with the cannabis investment sector. After so much hype and an even greater magnitude of disappointment, the weak hands – and some of the strong ones – have been flushed out. However, the recent optimism in Canopy Growth (NYSE:CGC), where CGC stock popped up nearly 11% on the Jan. 28 session, is worth taking a longer look.
Before we get into it, a word of caution: cannabis-based investments are incredibly risky. Although many analysts regard CGC as one of the better plays, the sector is virtually awash in red ink.
The major contenders like Cronos Group (NASDAQ:CRON), Tilray (NASDAQ:TLRY) and Aurora Cannabis (NYSE:ACB) have all taken massive hits, and I’m not talking the good kind of hit, either, not that I would know or anything.
If you’re ready for potentially severe volatility in exchange for outsized gains, here’s what happened: BMO Capital Markets analyst Tamy Chen gave CGC stock a vote of confidence, rating shares “outperform” from “market perform.” The new assessment is notable for two reasons.
First, with the ugliness in the cannabis market, most analysts have serious misgivings about weed. Second, Chen noted that Canopy was hurting itself unnecessarily with a poor product mix. With a current product mix that better matches the demand picture, Chen has confidence in a potential turnaround.
Here are three more reasons why CGC stock may offer a compelling entry point.
Canada’s Efficiency Opportunity
During the 2019 malaise in the cannabis sector, one criticism stood out: the Canadian retail market was shockingly inefficient. Administrative backlogs prevented businesses from attaining their necessary licenses in a timely manner. One of the results was a huge oversupply of products as the backlog choked supply chain pathways.
But the scope and context of the inefficiency is something that is worth considering. According to data compiled by Statista.com, top three provinces with the highest cannabis store density are Newfoundland and Labrador, Saskatchewan, and Manitoba. However, these three provinces feature some of the smallest communities of adult cannabis users.
On the other end of the spectrum, Ontario, Quebec, and British Columbia feature the least cannabis store density. But these are the three biggest communities of cannabis users, averaging 1.22 million users per province! In contrast, the former three provinces average less than 145,400 users.
When I ran the correlation analysis, I got a coefficient of -60%. That’s a strong inverse relationship. Mathematically, it indicates that as the cannabis user community rises, the number of stores to serve them decreases.
Obviously, that’s a gargantuan headwind against CGC stock and its ilk. But it’s an administrative headwind, not something inherent to Canopy’s business structure. If the Canadian government can get its act together – and they have every incentive to do so – we could see a rising tide lifting all boats.
CBD an Underappreciated Catalyst for CGC Stock
Back at home, our government isn’t exactly a paragon of botanical progressivism. Despite ample evidence of Prohibition-style, morality-based policies being prone to failure, the feds still consider marijuana a Schedule I drug.
But in a rare showing of bipartisanship, Democrats and Republicans came together to sign the Agriculture Improvement Act of 2018. Colloquially known as the 2018 farm bill, this measure was significant because it legalized industrial hemp and its derivatives. And one of those derivatives is a cannabinoid (or organic compound) called cannabidiol.
Abbreviated as CBD, cannabidiol is significant because it’s a highly potent cannabinoid, with advocates purporting health benefits. But the biggest takeaway with CBD is that it features little to no tetrahydrocannabinol (THC), marijuana’s notorious psychoactive compound. Under the farm bill, hemp and hemp-derivatives cannot contain more than 0.3% THC content.
Stated differently, CBD allows everyone to have their cake and eat it too: you can use organic material as a therapy but not get debilitated from it (or go to jail).
Now, CBD is also big for CGC stock because Canopy quietly introduced its CBD brand, First & Free, stateside.
Granted, the competition is fierce and saturated. However, here’s something distinct about the U.S. CBD market: its customers are willing to pay big bucks.
According to New Frontier Data, the largest category of monthly CBD customers is those who pay $101 to $200. In sharp contrast, the largest category of monthly customers of all cannabis products is those who pay under $20.
That tells me that the CBD-specific customer is generally affluent and seeking high-quality brands over a discounted price. If Canopy wins the branding game here – and why wouldn’t it with backers like Constellation Brands (NYSE:STZ)? – CGC stock could skyrocket.
Massive Technical Discount
Finally, we arrive at the most obvious point: CGC stock is on discount.
Admittedly, neither Canopy Growth nor any other pure cannabis company features confidence-inspiring financials. And with the Canadian supply chain issues, the hype that was initially built into the share price grotesquely unraveled.
At the same time, CGC stock is turning into a classic, albeit risky contrarian opportunity. For instance, some of the reasons for why Canopy and the sector stumbled had nothing to do with their businesses. Rather, the Canadian government grossly underestimated overall demand and made poor, inefficient decisions.
Furthermore, Wall Street hasn’t really priced in the subtle bullish points, such as Canopy’s CBD business, until recently. Naturally, most investors are leery and skeptical about cannabis stocks. But as a contrarian, that’s also the perfect time to strike.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.